Economizing on liquidity with deferred settlement mechanisms

Johnson, Kurt; McAndrews, James J.; Soramaki, Kimmo

Journal Article

Economizing on liquidity with deferred settlement mechanisms

Abstract: Credit extensions to banks using the Fedwire Funds Service-the Federal Reserve's real-time gross settlement (RTGS) payments system-can reach intraday peaks as high as $86 billion. This article evaluates the effectiveness of alternative methods of settling Fedwire payments in reducing intraday credit extensions. The authors simulate three deferred settlement mechanisms that complement RTGS systems: one-hour netting, six-hour netting, and a mechanism called a receipt-reactive gross settlement (RRGS) system. Their results suggest that in conjunction with RTGS systems, the RRGS mechanism could significantly reduce daylight credit extensions while modestly delaying the average time of payment settlement. Moreover, certain features of RRGS systems may encourage banks to submit payments earlier in the day. Further research on RRGS systems may shed light on whether they could prove to be a true liquidity-saving complement to real-time gross settlement systems.

Keywords: Clearinghouses (Banking); Fedwire; Liquidity (Economics); Payment systems;